The Important Tax Difference Between Term Life and Whole Life Policies

Buying the right life insurance policy as part of an effective estate tax strategy can be a tricky task. Many policies do not provide for future tax savings and it is not unusual to find that the benefits of a policy do not match up at all with expectations. A timely review of your policy with your agent is critical to make sure you have the right policy.

If you have a business that you would like to preserve for your family and you have selected a term life insurance policy you should be aware that these policies are intended to pay at face value if the policy holder dies within the period of coverage. Term policy premiums can be fixed for 10-20 years and renewal is typically an option at the end of the term for another 10 or 15 years, but at an increased new premium based on your new age which might be several hundred thousand dollars per year.

Be aware that term policies have a specific purpose: to replace lost income from a premature death. Term insurance effectively covers the risk of lost income for a set number of years, but it doesn’t build wealth for the future. So relying on a term policy to cover the costs of estate taxes is not wise.

If you anticipate paying sizeable estate taxes by the time you are in your end years, you’ll need a whole life insurance policy that lasts for your lifetime. In addition to paying a death benefit, these policies also work like savings accounts, building cash value that you can borrow against or redeem. They also get a big tax break because the earnings on the savings are not subject to income tax at any time.

Term policies and whole life policies are intended for different financial needs. Term life insurance efficiently and inexpensively protects against the risk of lost income for a specific number of years. Permanent policies are designed to last for a lifetime; they effectively guarantee that a specified amount of wealth is accumulated for whatever family, charitable, or estate tax needs you might consider.